Fed may circle back to mortgage-backed securities

Nomura cites informal 35% rule in quantitative-easing analysis

NEW YORK (MarketWatch) — The Federal Reserve may have to expand what types of bonds it buys or their maturities if its second quantitative-easing program looks likely to top $600 billion, strategists at Nomura Securities said in a report Monday.

The U.S. central bank’s already buying intermediate-term Treasury bonds as it recycles cash from its maturing mortgage holdings. Those purchases could total nearly $490 billion in the next 12 months, according to the report prepared by a Nomura team led by George Goncalves, head of U.S. rates strategy. Read more on Treasury bonds.

Since it announced that program in August, the Fed’s bought about $64.8 billion, according to Morgan Stanley.

Nomura’s economists expect the Fed will announce a $200 billion to $400 billion purchase program this week, while keeping the option of expanding it further. These purchases — dubbed QE2 to denote that it’s the Fed’s second round of so-called quantitative easing — could eventually total about $600 billion, according to Nomura — the level at which complications may start.

The Fed voluntarily sticks to a rule for private investors that prohibits it from buying more than 35% of a given security at auction, which could make the outstanding securities less liquid — not something the Fed wants.

So sticking to that rule may mean the Fed circles back to buying agency mortgage-backed securities, of which there are more in circulation, in the manner than it did in the first round of quantitative easing during the credit crisis.

“This rule may lead the Fed to consider buying other asset classes and agency MBS market may be the natural choice if the total size of QE2 were to be more than $600 billion,” the analysts wrote in a note.

It would be impractical for the Fed to just buy more in shorter-dated debt or inflation-indexed securities, according to Nomura.

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